II Absolute and Comparative Advantage A Absolute advantage

II. Absolute and Comparative Advantage A. Absolute advantage B. Comparative advantage C. Trade

60 second preview of absolute and comparative advantage https: //www. youtube. com/watch? v=U 12 y. ZXBm. Qm. Y

II. Absolute and Comparative Advantabe A. Absolute Advantage 1. the ability to produce more of something with a given amount of time and resources. est b e r a e We w usie and s. S friend nd we are ya Tomm h you c a e t to going e and t u l o s ab about tive a r a p com tage. n a v d a

Let’s look at example of absolute advantage using snack foods as an example. I like to snack on M&Ms and goldfish !! o o t e M

Susie’s Production Possibilities Curve 50 M&Ms Tommy’s Production Possibilities Curve 15 M&Ms 15 goldfish 25 goldfish Who has absolute advantage in M&Ms? Susie Who has absolute advantage in goldfish? Susie an 0 c I e 5 r k so a m M M& 25 sh i f d l go I can make 15 M&Ms or 15 goldfish

Susie’s Production Possibilities Curve Tommy’s Production Possibilities Curve 50 M&Ms 15 M&Ms 25 goldfish an e v te a h I lu in o s ab tage s n &M a v ad th M fish bo Gold and 15 goldfish

II. Comparative Advantage and Trade A. Absolute Advantage B. Comparative Advantage 1. the ability to produce something at a lower opportunity cost than someone else 2. not the same as absolute advantage

Susie’s Production Possibilities Curve 50 M&Ms Tommy’s Production Possibilities Curve 15 M&Ms 25 goldfish 15 goldfish e FIRST – you need to calculat opportunity cost. What is the opportunity cost of 1 M&M?

Susie’s Production Possibilities Curve 50 M&Ms Tommy’s Production Possibilities Curve 15 M&Ms 25 goldfish 15 goldfish To calculate opportunity cost put the other product over the one you are calculating opportunity cost for then reduce the fraction. What is the opportunity cost of 1 M&M? Goldfish = 25 = 1 SO 1 M&M = 1 goldfish M&M 50 2 2

Susie’s Production Possibilities Curve 50 M&Ms Tommy’s Production Possibilities Curve 15 M&Ms 25 goldfish 15 goldfish To calculate opportunity cost put the other product over the one you are calculating opportunity cost for then reduce the fraction. What is the opportunity cost of 1 goldfish? _M&M_ = 50 = 2 SO 1 goldfish = 2 M&M goldfish 25

Susie’s Production Possibilities Curve 50 M&Ms Tommy’s Production Possibilities Curve 15 M&Ms 25 goldfish What is the opportunity cost of 1 M&Ms? goldfish = 15 = 1 goldfish M&M 15 What is the opportunity cost of 1 goldfish? _M&M_ = 15 = 1 M&M goldfish 15 15 goldfish To calculate opportunity cost put the other product over the one you are calculating opportunity cost for then reduce the fraction.

Susie’s Production Possibilities Curve Tommy’s Production Possibilities Curve 50 M&Ms 15 goldfish 25 goldfish Suzie’s Opportunity Cost 1 M&M 1/2 goldfish 1 goldfish 2 M&Ms Tommy’s Opportunity Cost 1 goldfish 1 M&M

To determine comparative advantage look at opportunity cost. The person with the lowest opportunity cost has the comparative advantage. Who has the comparative advantage in M&Ms? Who gives up the LEAST goldfish to make M&Ms? Susie Who has the comparative advantage in goldfish? Who gives up the LEAST M&Ms to make goldfish? Tommy Suzie’s Opportunity Cost 1 M&M 1 goldfish Tommy’s Opportunity Cost 1/2 goldfish 1 goldfish 2 M&Ms 1 M&M

II. Comparative Advantage and Trade C. Trade 1. Specialization – each person engages in a different tasks 2. Gains from trade – dividing tasks (specializing) and trading benefits both parties

Back to our snack example!

Susie’s Production Possibilities Curve 50 M&Ms Tommy’s Production Possibilities Curve 15 M&Ms 40 5 25 goldfish 15 goldfish I’m going to make 40 M&Ms and 5 goldfish How many total snacks does Suzie have? 45

Susie’s Production Possibilities Curve 50 M&Ms Tommy’s Production Possibilities Curve 15 M&Ms 7 40 5 25 goldfish 8 to s g oin &M g I’m e 7 M fish k ma 8 gold and How many total snacks does Tommy have? 15 15 goldfish

Susie’s Production Possibilities Curve 50 M&Ms Tommy’s Production Possibilities Curve 15 M&Ms 25 goldfish 15 goldfish Yo us in hou the ld spe a r yo ea cia u ad com ha whe lize va v p nta ar e a re ge ativ an e dt rad e

Susie’s Production Possibilities Curve Tommy’s Production Possibilities Curve 50 M&Ms 15 M&Ms 7 40 5 25 goldfish Production Goldfish Consumption 7 M&M 50 40 Goldfish 15 8 M&M 15 goldfish 8 10 Traded 10 7

Susie’s Production Possibilities Curve Tommy’s Production Possibilities Curve 50 M&Ms 15 M&Ms 7 40 5 8 25 goldfish 15 goldfish How many snacks did each person gain? Production Goldfish Consumption Traded 7 M&M 50 40 10 Goldfish 15 8 7 M&M 10 +2 +3

Watch an example of comparative advantage. https: //www. youtube. com/watch? v=j. NESLIb. M 8 Ns

Comparative Advantage and Trade with Bert and Ernie

Suppose that Bert and Ernie both produce apples and bananas from their available resources but they do not currently trade with one another. The table below gives the number of hours of labor needed to produce one apple or one banana. NOTICE the information you have is about productivity --- you need to convert this into OUTPUT Hours of labor needed to produce one apple Hours of labor needed to produce one banana Bert 2 4 Ernie 3 1. 5

Suppose Bert and Ernie have 120 hours of labor time. What is the maximum number of apples and bananas they can produce? Hours of labor needed to produce one apple Hours of labor needed to produce one banana Bert 2 4 Ernie 3 1. 5 Apples produced in 120 hours Bert Ernie Bananas produced in 120 hours

Suppose Bert and Ernie have 120 hours of labor time. What is the maximum number of apples and bananas they can produce? Hours of labor needed to produce one apple Hours of labor needed to produce one banana Bert 2 4 Ernie 3 1. 5 Apples produced in 120 hours Bananas produced in 120 hours Bert 120/2 = 60 apples 120/4 = 30 bananas Ernie 120/3 = 40 apples 120/1. 5 = 80 bananas

Sketch a production possibility curve for Bert and Ernie showing how much fruit they can produce? Assume a constant opportunity cost. Apples produced in 120 hours Bananas produced in 120 hours Bert 60 30 Ernie 40 80 Bert’s Production Possibility Curve apples Ernie’s Production Possibility Curve apples 50 50 40 40 30 30 20 20 10 10 10 20 30 40 50 60 70 80 bananas

Who has the absolute advantage in apples? Bert Who has the absolute advantage in bananas? Ernie Bert’s Production Possibility Curve Ernie’s Production Possibility Curve apples 50 50 40 40 30 30 20 20 10 10 10 20 30 40 50 60 70 80 bananas

Determine the per unit opportunity cost. Apples produced in 120 hours Bananas produced in 120 hours Bert 60 30 Ernie 40 80 Apples Bananas Bert 1 apple = ? 1 banana = ? Ernie 1 apple = ? 1 banana = ? Remember – the other product goes over the one you are determining opportunity cost for.

Determine the per unit opportunity cost. Apples produced in 120 hours Bananas produced in 120 hours Bert 60 30 Ernie 40 80 Apples Bert Ernie Bananas 1 apple = 30/60 = ½ banana 1 banana = 60/30 = 2 apples 1 apple = 80/40 = 2 bananas 1 banana = 40/80 = ½ apple Who has the comparative advantage in apples? Bert – Bert only give up 1/2 a banana for each apple where Ernie gives up 2 Who has the comparative advantage in bananas? Ernie – Ernie only gives up ½ an apple for each banana where Bert gives up 2

Terms of Trade Apples Bananas Bert 1 apple = ½ banana 1 banana = 2 apples Ernie 1 apple = 2 bananas 1 banana = ½ apple Bert will specialize in apples and Ernie will specialize in bananas and they will trade. How many bananas must Bert get per apple to make the trade worthwhile? ½ banana – you must get AT LEAST your opportunity cost How many apples must Ernie get per banana to make the trade worthwhile? ½ apple – you must get at least your opportunity cost Is a 1 for 1 trade profitable for both Bert and Ernie? YES